CAIA level 1 - Topic 6 Structured Products questions with correct answers

Primary economic role of structuring - Answer Structured securities complete the market - structured to meet all different needs & helps investors prepare for all states of the world MBS - Answer Mortgage-backed securities - security secured by pool of mortgages (mortgages are the collateral) RMBS - Agency RMBS - Answer Residential MBS - low credit risk: backed by the US government - has prepayment risk: borrower' s right to repay mortgage early a key risk Contraction risk - Answer Average life decreases when rates fall and prepayments increase Extension risk - Answer Average life extension as rates rise and prepayments fall CMO - Answer Collaterialized Mortgage obligations - pool of mortgages are divided into tranches - collects and sell risk exposure to contraction rick & extension risk Sequential-pay tranches - Answer Tranches retired sequentially - senior tranches receives all principal until paid off - all tranches receive interest - each sequential-pay CMO tranche has a mix of contraction and extension risk